WHAT IS A PREMIUM ISSUE ?

Generally, most shares have a face value (i.e. the value as in a balance sheet of Rs.10 though not always offered to the public at this price. Companies can offer a share with a face value of Rs.10 to the public at a higher price.

The difference between the offer price and the face value is called the premium. As per the SEBI guidelines, new companies can offer shares to the public at a premium provided :

1.The promoter company has a 3 years consistent record of profitable working.

2.The promoter takes up at least 50 per cent of the shares in the issue.

3.All parties applying to the issue should be offered the same instrument at the same terms, especially regarding the premium.

4.The prospectus should provide justification for the propose premium. On the other hand, existing companies can make a premium issue without the above restrictions.

A company’s aim is to raise money and simultaneously serve the equity capital. As far as accounting is concerned, premium is credited to reserves and surplus and it does not increase the equity. Therefore, a company which raises Rs.100 crores by way of shares at say Rs.90 premium per share increases its equity by only Rs.10 crores, which is easier to service with an investment of Rs.100 crores.

Thus the companies seek to make premium issues. As well shall see later, a premium issue can increase the book value without decreasing the EPS. In a buoyant stock market when good shares trade at very high prices, companies realize that it’s easy to command a high premium.